Strategy Corner....Dividends and Share Buy Backs. (It's been a while)

Keeping in line with our strategy to look for new and innovative investment ideas, I bring you the following:

Dividends and Share Buybacks

Over the years, companies have created shareholder value through share repurchase programs and/or dividend increases. By share repurchase program we are referring to companies that buy back their stock in the open market. Both policies can create value for shareholders although there is an ongoing debate as to how much value is created, and which is the better use of free cash flow.

Certainly, the permanence of a dividend increase tends to be a better indicator of financial health and investors like to see dividends credited to their accounts. That said the return of cash to shareholders through share repurchase programs also benefits shareholders by reducing the number of shares outstanding, boosting earnings per share, and providing support for the share price. In this report, we have attempted to identify companies that have a history of consistently delivering on both shareholder friendly policies.

U.S. Corporations Flush with Cash

U.S corporations are sitting on record levels of cash with non-financial corporate businesses holding U$2.12 trillion in liquid assets at the end of the third quarter of 2011. High free cash flow yields combined with low returns generated on cash holdings should lead to increased dividend payments to shareholders and share buyback activity. In 2011, S&P 500 companies paid U$256 billion in dividends to shareholders, or about 29% of earnings. That’s well below the long-term average payout ratio of 47%. In 2011, U$530 billion worth of share buybacks were also authorized, up nearly 45% from 2010.

16 Companies with Investors’ Interests in Mind

We screened the S&P 100 Index of U.S. mega cap stocks, looking for companies that consistently repurchased shares and increased dividends over the past five years. To qualify, a company must have repurchased and reduced its common shares outstanding, and increased its dividend in each of the last five years without exception.

When creating our list, why did we not simply look for cash-rich companies with high free cash flow yields? Far too many management teams have destroyed shareholder value with poor investment decisions. Share buybacks and dividends put cash directly back into shareholders hands. However, these shareholder friendly policies should not come at the expense of strategic investments that could positively impact a company’s long-term growth and financial health.

There are 16 companies in the S&P 100 that met our selection criteria. Industrials, in particular defense companies, large retailers, and health care companies dominate the list. The stocks on the following page are ranked based on yield, decline in shares outstanding, and growth rate in dividends. On the basis of these three equally-weighted factors, Lockheed Martin (LMT) tops the list. On average, over the last five years, this defense company has reduced its shares outstanding by 5.3% per year while increasing its dividend annually by an impressive 21%. The shares currently yield 4.8%. Runner-up Texas Instruments (TXN) repurchased a similar amount of shares, but its Board was more aggressive in terms of annual dividend increases. However, the chipmaker’s shares yield only 2.1% at their recent quotation.

*Call or send me an email to discuss the companies that passed the test, and how this strategy may be a possible addition to your current investment policy.

Best Regards and Safe Investing!

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